May 9, 2024 - This week SIFMA and SIFMA Asset Management Group published a White Paper asserting that, contrary to the position of the Securities and Exchange Commission (“SEC” or “Commission”) that the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) significantly expanded its authority to overhaul adviser custody rules, Dodd-Frank provided no such mandate.  Moreover, the proposed rule is also inconsistent with historical precedent for advisory custody regulation. The White Paper is important to LSTA members because, as we’ve previously written SEC’s Safeguarding Rule Proposal (the “proposed rule”) will have far-reaching effects on how registered investment advisers manage and safeguard client assets. As written, the proposed rule would impose significant burdens and costs on loan managers, including, at a minimum, a requirement to arrange for an annual surprise audit, and would completely alter their relationships with custodians. Loan custodians would be required to accept significantly more liability, provide extensive written assurances to advisers and be subject to very prescriptive rules. A worse outcome would require the manager to engage an independent accountant to, in effect, watch every trade and report discrepancies to the SEC in near-real time. Beyond the loan market the proposed rule would impose a wide range of new requirements on registered investment advisers and impact a wide range of other market participants, including clients, custodians, and broker- dealers.

SIFMA makes four key points: First, the legislative history shows that contrary to the SEC’s position, Section 411 of Dodd-Frank was not a mandate or grant of authority to overhaul adviser custody regulation, but instead was a codification of measures the Commission took in 2009. Second, the legislative history of Section 411 shows that there was no Congressional intent to expand the scope of adviser custody beyond “funds and securities” and, therefore, the Commission’s intent to regulate such “assets” exceeds its statutory authority. Third, deeming advisers with discretionary trading authority to have “custody” for purposes of the Advisers Act has no legislative foundation and is contrary to over 80 years of investment adviser regulation. And fourth, the proposed rule’s written agreement and reasonable assurances requirements (required from custodians) exceed the Commission’s rulemaking authority under the Advisers Act and Dodd-Frank.

The White Paper explains each of the points in detail and concludes with a statement about how far the current proposed rule deviates from the SEC’s long history of custody regulation for investment advisers. SIFMA notes that the Commission’s first rulemaking occurred in 1962 and, since then, the SEC has further refined and adjusted requirements based on pre-Dodd-Frank authority. The recent proposed rule, in contrast, relies heavily on authority the Commission references in Dodd-Frank and characterizes Dodd-Frank as a grant of new and expanded authority. The legislative history shows that Dodd-Frank affirmed and codified existing authority but was not a mandate or an expansion and the proposed rule is at odds with the SEC’s own prior regulatory history. The paper ends by noting that “any further consideration of investment adviser custody regulation by the Commission will need to acknowledge and remain consistent with its authority” and that the “goal of this paper is to contribute further knowledge and understanding of the historical landscape to better inform the Commission’s approach.”

Next Steps.  The proposed rule has not been finalized and it is not clear when or whether it will ultimately be approved in its current form. The LSTA will continue to closely follow this matter.

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